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Déjà vu : Rinse and repeat the old Gyan

March 15, 2019
Those who cannot remember the past are condemned to repeat it”…. George Santayana

Of late I have received several frantic calls from worrisome investors with regards to where the stock markets are heading. They have been perplexed by the fact that the broad market index continues to remain resilient while the performance of their own portfolio is slumbering. So how do we gauge the current scenario and what next to do?

To understand the current scenario we will need to go a few years back to 2013 when the Nifty index had hit a bottom just before the ascent of the NDA government. Crude prices tanked soon after the elections in 2014 and stayed there for an unprecedented period, interest rates declined sharply and remained low for nearly four years. Earnings momentum and credit growth were in double digits. Political scenario was stabilizing. Nifty traded at 17X PE…

The scenario is quite opposite today. Markets are trading at an all-time high. The index has doubled over the last six years and valuations have bloated to reach the upper end of the trading band (c27x). Interest rates are inching higher and faster. Crude price is no longer benevolent and local fuel prices have already touched record highs. Inflation is rising, corporate earnings is declining and national elections are soon approaching….in short it’s déjà vu for most money managers!

The double digit earnings growth prevalent in 2013 has currently slumped to low single digits now. We have a situation wherein prices have moved higher incoherent with the earnings growth (PE expansion-bubble). Market forces generally adjust to bring valuations to a more rational level. This adjustment has already begun. The broad market Nifty 50 index is almost flat this year with a YTD return of 2.2%, while the Mid-cap 50 index is down over 12% and the Small cap 50 index is significantly lower at 24%. Despite this decline in Mid and Small cap indices they still trade at an exorbitant valuation of 53x and 131x respectively. Still a long way to go!

The easy solution. If you think you will get a nervous breakdown and you are incapable of handling the current volatility… then just GET OUT… and come back at a better time (something we strongly recommend). Park your funds in short term money market instruments and gradually re-enter at lower levels. This may sound simple, but to implement and stay put till the clouds clear will require a strong temperament.

Alternatively, stick to the basics, which means…rinse and repeat the old gyan…

Invest in well-known Goodies: Look for companies that are low leveraged, stable growth, robust management, market leaders and large cap. Such companies will always find buyers and they will come out better from any recession. Exit companies that have uncertain volatile and complicated earnings model.

Sell high buy low- follow the PE, understand market cycles: If you believe that we are at a tipping point (which could be true) then investors who stay put now should be clear about their time horizon and look only for the long haul.

Acknowledge risk of Research failure – There are no futurists. Fund Managers, analysts are just creative human beings and they can go wrong (multiple times!) especially at market peaks.

Focus on capital preservation: Don’t feel shy of holding cash and to receive subpar returns. It will only enable you to enter at a better level and outperform later.

Finally, control emotions: don’t watch the commentary on TV, just read the news

Over the last 5 years or so, investing has seemed to be an easy business with sentiments upbeat, few disruptions, low volatility and an overall risk averse attitude. Going forward irrespective of whether you expect the market to move higher or lower, one thing is for sure, the environment has changed and the ride is going to be bumpy.

March 15, 2019

100 years of good health – Britannia

February 21, 2019

These are startup times, and almost daily we are bombarded with innumerable products and services. It is becoming increasingly difficult to remain loyal to a company or brand. Most of these companies burn themselves out within a few years, get acquired by competition, venture into unrelated areas and thus end up looking totally different from where they had started. On the other hand, there are old school corporations that have retained their key values, manufactured the same product and remain entrenched in the ethos of a society. These companies offer great learning’s and become legendary textbook material. One such institution recently completed 100 years in its existence- Britannia.

Britannia as the company we now know of began in a baking kitchen in Calcutta in 1918. It was acquired by VK brothers who later partnered with an English businessman C.H. Holmes and publicly incorporated Britannia Biscuits. In 1921, the company became the first mechanized biscuit manufacturer in India… and we have been munching on ever since…

 

From an initial investment of Rs. 295 about 100 years ago, Britannia is currently a Rs.70,000cr market cap conglomerate with a host of offerings including Breads, Rusk, Cakes, Wafers and value-added Dairy. It now sells 1.3bn units a month which is equal to 1.2bn tons of biscuits annually, consumed in 18cr households across the country. The company has overcome two world wars, several economic cycles, political uncertainties and numerous changes in its ownership along its long history. It has withstood the test of time primarily due to three important factors: Pricing, Network and Brand

 

In spite of the product line going through continuous renovation and innovation, the pricing strategy has remained the same. Despite aggressively pursuing market share and profitability, the end goal of the company has always been to retain its base of consumers offering them quality products at affordable prices. Britannia’s products have never been hard on the pockets and it is synonymous with the middle class. Even the premium snack segments have Low unit packs (LUPs) that are cleverly priced below Rs.15 and cater to every segment of the society.

 

Britannia maintains a mindboggling web of sales channels which include 4,000 distributors, 30,000 sales persons who ensure supply across 45,000 villages and to every town and city in the country. Its products are also available in 78 countries through 52lakh retail outlets. Getting to so many geographic locations is no easy task. The company utilizes several unique delivery methods such as boats in the backwaters of Kerala, bullock carts in Madhya Pradesh and camel carts in Rajasthan to reach the remotest part of the country. It would take several years to emulate such a supply chain model and many new entrants have failed only because they have struggled to build their logistic network. Reaching every potential consumer should be the ultimate focus of any company and Britannia has always been on top of it.

 

Over 70% of Indian households consume Britannia products, which becomes 80% in urban India and a staggering 90%+ in metros. Branding has played a very important role in increasing the penetration level of the products. For generations, Britannia has been seen as a household necessity which can be enjoyed at every occasion and by any age group. Very few consumer products have been lucky to be associated equally with the common man, children and elderly. It was rightfully conferred “Superbrand” status for its accomplishments and also has 8 power brands in its portfolio. Some of its classic brands like Bourbon established as early as 1955, Milk Bikis, Good Day, Marie Gold etc. have great brand recalls across generations. It is estimated that the Britannia brand could be valued in excess of $6bn.

 

The company has managed to maintain focus on core businesses despite rapid expansion of new ones signaling a mature company with an appropriately aligned leadership. Britannia’s consistent success over such a long period is the tangible evidence that proves, businesses do not need to sacrifice the wellbeing of their fundamentals in order to consolidate market share in their respective industry. Margins need not be bludgeoned to provide affordable products to consumers on a mass scale and futuristic business models validating such losses are not always the way to go.

 

As Jim Collins made famous in his book, Built to Last: Having a great idea or being a charismatic visionary leader is “time telling”; building a company that can prosper far beyond the presence of any single leader and through multiple product life cycles is “clock building.” Companies must strive to be clock builders and not just time tellers to create and develop a business-like Britannia that can excel in the test of time…

February 21, 2019

A tribute to John Bogle: The Big guy who cared for the Little guy

January 28, 2019

While there have been several brilliant minds that invented innumerable things for the betterment of the human race, there would only be a handful that created an impact so distinctly in the Big Bad world of investments. John C. Bogle stands tall in this respect for creating wealth across the spectrum of investors and more importantly for the “little-guy” out there.

John grew up during the Great Depression and what he witnessed in his formative years inspired him to constantly strive for the benefit of the middle-class investors. He started his career post WWII at a time when the US stock markets were in a continuous roll. Active fund managers were God-like figures extracting exorbitant fees from investors promising unsustainable returns. Not surprisingly, during this time Bogle’s company Vanguard was a damp squib in the muddle and only managed to accumulate a tiny share of the funds. He was generally mocked by the investment fraternity for his lame methods. However, at the time of his passing at the age of 89, his triumph was total. His concept of low-cost index funds has emerged a favorite of the biggest asset managers and his brainchild, the Vanguard Group is now a $5 tn mammoth.

 

Bogle stood for two important things: Firstly, his premise that no active fund manager can consistently outperform the benchmark over a long period and secondly his persistent belief in putting customer interest first.

Almost no one consistently beats the benchmark over longer time periods

 

Bogle’s greatest success was his bet that average market/benchmark return would beat most active managers net of expenses and trading costs. The common investor finds it extremely difficult to actively pursue the task of outperforming the benchmark. It is even more daunting to identify an active fund manager who could do the same. Bogle thought, instead of spending time and effort on choosing the right Fund and Manager one should just buy the benchmark itself. This led to the creation of Vanguard index funds.

 

Bogle’s idea was so simplistic that it became repulsive to the intelligentsia of those times. Along with simplicity he also advocated discipline in investing and cutting through the wall street chaos and to be unperturbed by rumors. His ultimate focus was to provide consistent risk adjusted returns sans volatility.

The business must be a fiduciary to its clients. The customer’s interest always comes first.

 

Bogle institutionalized charging minimal fees and taking lower shares of profits to ensure investors kept more of their money. Further, he set up Vanguard as a cooperative and as it grew in size the company would simultaneously cut fees, thereby transferring the efficiencies from economies of scale towards investors. This was in direct conflict with those institutions charging heavy fees and promising outlier returns. Although he was written off by the industry claiming it is destined to be a very low profit business; for Bogle that was the entire point!

 

It is estimated that the Vanguard effect compelled an entire industry to cut down its commissions and fees saving investors close to $1 tn over the 43 years of its existence. To put things in perspective, the Vanguard Total Stock Market Index Fund now manages a $672 Bn assets under management that purchases every single U.S. stock paying fees as low as 0.04% a year. More than the monetary savings, he initiated a paradigm shift in the way funds could be efficiently managed for the lay investor. Post the crisis of 2000 and 2008, funds from Pensions, Endowments and Retail have increased their exposure to these types of index funds.

In one of his famous annual letters to shareholders, champion investor Warren Buffet singles out John Bogle as the greatest contributor to investors in history. He lauded Jack’s persistence towards convincing investors to invest in Ultra-Low-Cost index funds. Buffet notes that Bogle can be rest assured that his dedication has directly led millions to realize far better returns on their savings than what they could have otherwise earned.

 

He might not have been a fancy text book material like the other “Gurus” but the impact he has created on the investment community will last forever. In his last publication, “Stay the Course” Bogle left his final warning to the investment industry: Don’t forget who you serve.

January 28, 2019

Gray Rhinos watch out!

December 18, 2018

Everything comes in circles…..The old wheel turns and the same spoke comes up. It has all been done before and will again”…

“THE VALLEY OF FEAR”

 

For those who came late….

The US economy was on cloud nine in 2008, having enjoyed the longest expansion since the Dot-Com bubble. Policymakers and investors believed the economy had grown to the next stage and that present levels of performance were sustainable. Housing prices, value of real estate steadily rose during this period thanks to the low interest rate regime in response to the crisis of 2000. Greedy Bankers introduced high risk derivative products keeping the mortgage loans as collateral. According to them there was no risk as long as housing prices remained buoyant, and it was stupid at that time to even imagine a decline. So, in order to create more derivative securities banks had to issue more mortgage loans. Banks were allowing several hundreds of thousands of people with questionable credit to take out loans. The more home loans banks lent, the more Mortgage-backed securities (MBS) they could trade.

 

These MBS were owned by the so-called intelligent investment community which encompass: hedge funds, financial institutions, mutual funds, corporate treasuries and even conservative pension funds. The insatiable demand for them led to banks cutting up several mortgages, packing them in ever increasing portions of subprime along with highly rated paper to give it a safe appearance while making it impossible to price.

 

In an unbelievable turn of events, housing prices faced a landslide fall of 31% after peaking in April 2007. Derivatives lost their value at an exponential pace, banks decided to stop lending money to each other based on these (now) worthless MBS’ as collateral. Interbank borrowing costs spiked with mistrust taking over the banking community pushing markets into the crisis of 2008.

…the solution

Now the Fed and Government had gotten into a crisis of proportion, it had created a real Lernaean Hydra. The crisis was considered next only to the Great depression. Frantic measures were undertaken post the closure of Bear Sterns and Lehman Brothers. One such measure was the very unconventional Quantitative easing (QE) policy. The Fed planned to increase liquidity through successive purchases of long maturing assets and mortgage-backed securities. It declared that once it witnessed a significant effect on inflation and employment the easing would gradually be phased out. However, the envisaged phase out never happened and the Fed Balance sheet ballooned to gargantuan size.

 

To put things in perspective, when QE1 began in November 2008, the Fed and Treasury approved a total spend of $605 billion in its bailout plan that swelled to at least a $100 billion more. The Fed bailed AIG out with $182 billion, $140 billion was rushed from money markets to treasury bonds. By the end of QE1 in June 2010 The Fed had injected $2.1 trillion into the economy. The economic de-growth of -2.8% witnessed in 2009 was reversed to a growth of 2.5% in 2010. However, in just three months after the end of QE1, the Fed posited that the economy’s growth was currently too weak to be sustainable. It began QE2 by purchasing $600 Billion of Treasury securities and further reinvested its proceeds on earlier investments of the tune of $300 Billion. It decided to stretch the plan over the next eight months until June 2011 at the end of which its total assets held stood at $2.8 Trillion.

 

Fears of runaway inflation were calmed as the fluctuation in consumer prices were contained in the range of 1-4% since its reversal from -2% in mid-2009. However, this did not satiate the Fed and its concern on economic growth. It initiated the final stage of easing in the form of QE3. By 2017 the Fed balance sheet had grown over $4.5 trillion significantly higher than the $800 billion it held before the financial crisis and the beginning of its stimulus. Interest rates were brought to zero levels in an attempt to bolster growth and to favor investments.

Solution creates the problem

 

The low interest rate regime and heavily inflated balance sheet severely affects the Fed’s ability to counter cyclically influence the economy in case of a recession. Taking cognizance of the situation it has started to reverse its accommodative stance. At the end of December 2018, the assets in the Fed’s balance sheet shrunk by about 10% to $4.07 trillion, its lowest level since the end of 2013. This evidences the Fed’s intent to shed its role as the “convexity supplier of last resort” and emerge as a manager of convexity instead. Further it began raising the funds rate in December 2015 from 0% to a range of 2.25-2.5% as of December 2018.

The Fed’s normalization will result in long-term interest rates slowly rising to a point that resembles historic rates. By doing this, the Fed’s policymakers intend to free up balance sheet capacity in case of future recessionary needs but mainly also put an end to hot money flows.

Impact on the markets

 

Growing liberalisation and international trade have brought Global financial relationships closer especially for developing economies. US monetary policy has been found to be a key trigger amongst other factors affecting investors risk preferences. The taper tantrum is on the rise again. S&P 500 is facing jitters at the top. It declined by over 10% in December last year, one of the biggest falls in recent times. Our markets are not alone, RBI on its part will follow the Fed and prop up its rates to maintain parity and save the Indian Rupee. Higher interest rates mean higher costs. Corporate earnings which has already been lull over the last few years will further decline and any increase in market price will only create a bubble-like scenario.

 

Michele Wucker in her book titled “THE GRAY RHINO: How to recognize and act on the obvious dangers we ignore” aptly places more importance on the evident dangers that are right in front rather than identifying hidden or imaginary risks. Shrinking of the Fed balance sheet is truly one such “Gray Rhino” that is marching head on towards us and we need to be prepared to face it or get bulldozed.

December 18, 2018

The Sisyphean curse and the Classic Error

November 19, 2018

It sometimes appears a futile attempt to understand the reckonings of the market. Fund managers are in constant pursuit to identify the best strategy. Analysts are forever discovering ways to assign fair values. Each cycle teaches new lessons, some contradicting while others complimenting the earlier learning’s. The journey is never complete and the knowledge never seems enough. But much like the Sisyphean curse, every stock market cycle has a similar story, investors make the same mistakes; and the boulder just falls off the hill once again!

With media screaming its head off about the index breaking new high’s, it’s difficult not to get distracted. The chaos affects your reasoning, evaluating skills and the creepy cognitive biases influence you to take decisions which you wouldn’t have otherwise. Most television commentaries are inconclusive and leave us more clouded than clear. With so much noise to comprehend, it is the Fear Of Missing Out (FOMO) that most often ruins a well-constructed investment strategy. FOMO becomes more intense as the market moves higher and higher and personal portfolios lag (as it is happening today!).

It is most unlikely to find success by mimicking the strategy that has worked well for someone. History provides several examples to this. Irving Fisher’s infamous prediction in 1929 just before the Great Crash ruined all those who followed him and almost finished his otherwise illustrious career. Benjamin Graham’s investment picks weren’t as good as his teachings on investment. It’s good to read Buffetology but highly improbable to follow. Timing, investment goals, temperament and several other factors vary from investor to investor, hence your neighbors size may not fit you. So don’t bother.
 
FOMO lets investors get more aggressive at the wrong time. For instance, under the current scenario the market is witnessing new highs on a daily basis. Unless temperament holds good, investors will be forced to jump into the exuberance. A closer analysis will reveal that the underlying fundamentals are not so supportive. Bloomberg data shows the latest earnings estimates have been downgraded for 57% of the 251 companies under coverage. It is estimated that Domestic currency can weaken further. RBI has indicated a rise in the interest rates and crude continues to hover near its recent highs. Focusing on the larger trend and the macro factors that affect it will offer solutions for prudent asset allocation. Then life becomes easier and assets are earmarked according to one’s investment goals and risk is captured appropriately.
 
The advent of social media has only exacerbated the FOMO and made decision making a lot harder. It drives you to look for immediate price sensitive information and meaningless discussions around them. Fancy hashtags along with intellectual quotes will always have a herd following. Latecomers will grapple to get hold on the information they missed and anxiety levels will unnecessarily rise. Social media has created a whole new breed of pseudo half-baked intellectuals who are now the majority influencers. It is wise to recognize them and stay clear. Researchers call it the Facebook illusion, where you get logged into the virtual world and logged out of the real one.
 

FOMO is primarily generated due to the lack of confidence in oneself. As the Guru himself quotes “investment is not a game where the guy with the 160 IQ beats the guy with 130 IQ. Rationality is essential”. We would add Temperament along with that. Investing in companies that are well researched and timing them prudently is not rocket science. Instead we constantly search and compare other people’s ideas and believe less in oneself. This will only create insecurity and leave the FOMO virus growing.Behavior expert Paul Dolan articulates it perfectly in his book, Happiness by Design: Change what you do, not how you think

Your happiness is determined by how you allocate your attention. What you attend to drives your behavior and it determines your happiness. Attention is the glue that holds your life together… The scarcity of attentional resources means that you must consider how you can make and facilitate better decisions about what to pay attention to and in what ways. If you are not as happy as you could be, then you must be misallocating your attention… So changing behavior and enhancing happiness is as much about withdrawing attention from the negative as it is about attending to the positive.

In conclusion, FOMO is a virus that spreads fastest when we are near the end of a rally. Check with your investment advisor if you already have it. It is better to look inward rather than outward for happiness as well as portfolio construction. Stick to the mandate/investment policy/investment goals provided rather than chasing the herd. Men are not equal, so are women- hence don’t compare.

Do not to succumb to the classic error of investing more at higher levels and break the Sisyphean curse this time around.

This article has been published in memory of those who had rushed into the tech boom rally or housing bubble and do not exist amongst us anymore! 🙂

 
 
November 19, 2018

Ultratech- A tangible growth story (for a change!)

October 3, 2018

Over the last decade or so investment philosophy has changed significantly. In the old school it was taught- Good companies are the ones that had consistent growth, profitable and maintained stable margins. Management bandwidth was judged based on the number of crises overcome, promises fulfilled, dividends paid out and creation of shareholder value. However, we live in times when intangible ideas are getting more valuation than tangible profits. The glamour of having invested in an IT related startup is superseding any far-fetched logic. Surely some of the guys in the room were a bit too high!

Hence its occasionally a pleasure to remind ourselves about unglamorous dusty stories which have gradually grown over time and offered significant returns to shareholders. Under the current scenario something simple that we can touch and feel is so much of a relief! This note is just a restatement…

The Birla Group founded in 1857 has one of the country’s most inspiring industrial journeys. It functions across 35 countries employing over 1,20,000 people. Its flagship, Grasim entered the Cement sector as early as the mid-1980s to service the insatiable need for infrastructure development in the country. Though the beginnings were humble with a capacity of 1MTPA the then Chairman Aditya Vikram Birla had envisioned the company to become a national leader. The liberalisation of the economy in the early 90s favoured pre-established players allowing the company to raise its capacity to 8.5 MTPA by 1998 and 14.12 MTPA by 2003. In 2004, Grasim completed its masterstroke by acquiring of L&Ts cement business: Ultratech Cement Ltd. which became the face of Grasim’s Cement operations.

In Ultratech Cement Ltd.’s first annual report (2004-2005) since Grasim’s acquisition K.M. Birla reiterated the vision of the founders which was made 25 years ago. Today, the company holds a 23% market share dominating national and regional markets. It will achieve the country’s highest installed capacity of 106.5 MTPA by 2019 (the nearest competitor way lower @ 31.6MTPA), a 100x growth in under 40 years of its existence!

Growth has come through a mix of both organic and inorganic methods. The Chairman unveiled Ultratech’s audacious growth plan in FY13 to scale capacities to 65 MTPA by 2015 earmarking a mammoth fund of Rs11,400 cr for capital expenditures. In FY14 acquiring Jaypee Cement’s 4.8MTPA subsidiary in Gujarat for Rs. 3,800 cr greatly strengthened the company’s presence in the promising western market also enabling it to boost exports through the coast. In 2016 Ultratech announced its takeover of Jaiprakash Associates’ Cement plants in Madhya Pradesh, Uttar Pradesh, Himachal Pradesh, Uttarakhand and Andhra Pradesh with a total capacity addition of 21.2 MTPA at an enterprise value of Rs.16,189 cr. Commissioning of grinding facilities in Haryana, West Bengal, Bihar along with a greenfield project in Madhya Pradesh took the capacity to 95.3 MTPA. Further Ultratech also acquired ETA Star Cement Company with its operational plants in UAE, Bahrain and Bangladesh thereby establishing its footprint globally. Despite intense competition in the sector and over supply issues, the persistent growth is a symbol of the Birla Group’s commitment to its shareholders and accomplishment of its promise of becoming the industry leader.

The company has focused on both top-line and bottom-line growth not giving one up for the other. Revenue has grown from Rs 2,693 cr. to Rs 30,683 cr., while profits have risen at a CAGR of 34% since 2004. The total assets in the balance sheet stand at Rs. 43,697cr multiplying 16 times since FY04. While the company has taken on debt for its growth, it has done so judiciously and only to cater to the attractive investment opportunities in the industry, unlike some its peers which diversified into unrelated businesses and paid the price for it. Its acquisition of key assets in respective regions has enhanced the mining and production capacities while being in proximity to their existing plants. This has helped reduce lead distance, inventory loads while simultaneously de-bottlenecking facilities and maximising operating efficiency. Further during the period FY06-09, Ultratech began building captive power plants in Gujarat and Chhattisgarh. Currently captive power production of 982MW and WHRS capacity of 65MW provides for over 85% of the company’s need. Through large investments made into R&D, Ultratech Cement Ltd. is consistently more efficient than its peers in production. This is proven by their ability to take acquired plants and run them more profitably through synergies from Ultratech’s bargaining power, efficiency, lower lead distance, better infrastructure, and economies of scale.

(HAM) road contracts and strict deadline clauses. Growth and improvement in infrastructure will augment the same in real estate. Concrete roads have been given the nod over bitumen roads which is a significant win for the cement industry. Ultratech is the nation’s top Ready-Mix Concrete supplier with 107 plants. The government has upped the target of laying roads at 30km/day. The Bharatmala project is set to be the largest single outlay for a road construction project worth Rs.5.35 lakh cr. Bullet train lines between Ahmedabad and Mumbai, a $17 billion project is expected to be completed by 2022. Mumbai Metro project alone is estimated to require 30,000 tons of Cement a month, not to forget the several other Metro projects underway. Further, the rising disposable incomes, migration to cities will auger well for the demand of new houses. It is estimated that the number of cities with a population of over 1 million people will increase to 87 from the current 53 by 2030. The government has planned several projects to accommodate this rapid urbanisation. Authorities have identified 20 out of 100 planned smart cities with an expenditure plan of $7.5 Billion over the next 5 years. The Pradhan Mantri Avas Yojna has sanctioned 8.5 million homes with plans to approve 60 million houses in total. Enormous costs of transporting cement, lack of substitute products and the capital-intensive nature of the business are barriers to new entrants. Large established players like Ultratech Cement are direct beneficiaries of the pan India development projects. Ultratech currently operates at an utilization rate of 70% and there is significant room to ramp up and service this growing demand.

Bored with all this Gyan…well that’s the point…!! To summarise, what makes Ultratech interesting is the fact that, since the takeover in 2004, the stock price of the company has appreciated by 15.4x compared to the Nifty index and Nifty Midcap index which gave a 6.7x and 5.7x returns respectively!! For an average investor it’s much easier to bet on such market leaders where tangible growth is visible and operations are easy to understand. Further, there are no major overseas investments siphoning money and the company thrives only on intrinsic demand. Investment becomes less stressful if the basics are catered to properly. The old school though boring, gets these basics right!

 
 
October 3, 2018

Thinking Fast and Slow – Book Review

September 14, 2018

“Thinking, fast and slowly” is a captivating read authored by Nobel Prize winner for Economic Science, Daniel Kahneman. A psychologist by profession he is renowned across disciplines for his work with long time academic partner Amos Tversky. Mutual doubts the two shared on Expected utility theory led to their research on Prospect Theory, the loss aversive consumer and Endowment effect.

Kahneman introduces us to the partition of the mind of the consumer as System 1 and System 2. He posits that System 1 is responsible for all actions that we perform without much contemplation and is usually good. It adapts a belief of “what you see is all there is” (WYSIATI). But system 1 has got systematic errors, it does not have any statistical understanding and works on “intuition”. Intuition is developed based on a consumer’s beliefs, heuristics and cognitive functions.

According the Kahneman System 1 makes the correct decision in most situations but is also the major source of errors made in decision making. He says, “the confidence people have in their intuition is not a reliable guide to its validity.” It is possible to acquire the skill to effectively use intuition, but this is dependent on the domain. Given that it is a predictable environment with sufficiently regular events and the opportunity to learn regularities through practice.

In environments where this is not possible Kahneman shows us how decision makers can fall prey to several effects (Halo, framing, substitution and anchoring), cognitive illusions (validity, skill and focus) and bias (confirmation, outcome and hindsight).

Solutions posed for systemic problems are instituting checklists, exercising reference-class forecasting and conducting a Pre-Mortem. We also see how simple algorithms designed that consider the factors involved in these decisions can significantly improve consumer choice as algorithms are not affected by such effects, illusions of hindsight or bias.

The book also brings to focus two types of agents; The fictitious economists dealing with theory and humans dealing with the real world. The latter does not have great logical and statistical understanding and hence requires assistance to make the right decision. Independent consumers tend to make uninformed decisions such as investing in a company that produces ones favourite cars or in the news. On the other side Institutional investors do not flock to stocks merely because they are popular but from performing complex financial analysis and refer to their valid body of knowledge and experience.

Kahneman warns that skill in stock analysis is not enough for trading, it also depends on whether the information about the stock has already been reflected in the stock price. Hence an understanding of the Microeconomic, Macroeconomic, industry specific factors and the lags that exist are vital. Optimism proves to be a problem for decision makers causing optimistic bias which results in planning fallacy. Planning fallacy describes plans that are unrealistically close to the best-case scenario and can be improved by consulting test statistics. Decision makers must be able to focus on the encouraging factors without losing track of reality.

The books final contribution is the segregation of the experiencing self from the remembering self. Kahneman notices the peak end rule and duration neglect while analysing the two selves. These factors and the contradiction between the experiencing and remembering self creates a bias that makes decision makers to favour short term high degree of happiness over long term moderate happiness. They prefer short periods but high tolerable pain to long one with moderate pain. This is a unique contradiction which Kahneman calls for future research to be conducted upon.

“Thinking, fast and slow” is a recommended read for investors and other decision makers who wish to streamline their thought process in order to overcome several inherent biases and make rational choices.

September 14, 2018

10 stocks 10x in 10 years

August 3, 2018

Now that we are at crossroads (or though it seems like), it is an appropriate time to look back and introspect. This has by far been the longest rally for the Nifty and has lasted for over 7 years (and not finished yet!). The previous cycle ended with the crash of 2008, and the markets bottomed out in 2009. Ever since, Nifty has appreciated by over 4.3X. We take note of the top 10 performers who surpassed expectations and returned over 10x during the last 10 years. What made them outperformers and is there a common thread connecting these companies? Can the learning’s from the past hold answers to the future…

One of the key reasons for the success of any company is the continuity in strategy. This is possible only if the leadership is stable. All of these top performers have had no change in their top management for several years. Sanjiv/Rajiv Bajaj of Bajaj Finance/Bajaj Auto and Siddartha Lal of Eicher Motors have been instrumental in turning around their respective family businesses into modern institutions. Today these institutions are amongst the best in their own segments. When Romesh Sobti and his team moved into Indusind in 2007 little did anyone expect such a drastic change within this ailing Bank. Today it boasts of being amongst the top banks in the country; and the dream run continues with the same team. Rana Kapoor of Yes Bank and Aditya Puri of HDFC Bank have been at the helm since the inception of their respective banks. They have managed to maintain a boringly steady rate of growth without compromising on asset quality. RC Bhargava (Chairman, Maruti), KBS Anand (MD/CEO, Asian Paints) and Bhaskar Bhat (MD, Titan) have all been associated with their respective companies for their entire careers. They are industry veterans and have taken their companies to leadership positions.

Many companies in the past have taken unnecessary bets and aggressively acquired overseas in an attempt to showcase themselves as a Multinational Company. However most of them have only failed and the assets have given more pain than gain. None of the companies in the top 10 list have attempted any such acquisition nor have they proceeded outside the domestic market, catering only to local/intrinsic demand. This has helped them focus their resources in areas where they can do best. Offering products and services that cater to the larger audience, scalable operations and use of technology have been the main reasons for the success of these companies. Bajaj Finance, Maruti, Asian Paints are excellent examples of entities that have made good use of the market they exist in. Bajaj Finance has introduced an array of financial products targeted at the large middle class population. Easing the lending process with products such as pre-approved EMI cards have been a great hit amongst the consumers. In the case of Maruti, they have continuously launched passenger vehicles that have delighted the common man. Despite significant competition, Asian Paints has maintained over 50% market share and has been the biggest beneficiary of the boom in domestic construction industry.

Maruti despite its growing production line has remained a zero debt company, so is the case with Asian paints, Bajaj Auto and Eicher motors. Even in the case of the Banks and NBFCs, the leverage ratio has been much below industry standards. With no interest outflow, the cash from business has been ploughed back; resulting in a compounded growth over the years. The focus has always been on making cash profits and this has worked well with all of them.

The non-promoter holding for all the companies in the list range between 40-80%. They all have independent directors on the board and seldom have we heard of any creepy corporate governance issues. The return on equity has been well maintained >15% mark consistently over the years. There has not been any major fund raising by these entities via equity dilution.
The thread that ties these top gainers is obvious. They have managed to improve on what they have already been doing in the past and most importantly they have not tried anything outside their area of competence. Instead they have innovated in the process, product and technology. Created more robust platforms that are scalable and cater to a larger audience. Never has there been such an amicable and productive demerger of a business that has created value for all stakeholders alike as in the case of Bajaj Auto. Re-inventing the old Bullet gave Eicher motors the thrust it badly required. Re-branding an old watch company made Titan what it is today. Offering stylish, efficient and affordable cars keeps Maruti ahead of the competition. Despite being big players in the Banking sector, holding on to the basics has helped HDFC Bank, YES and Indusind bank steer clear from the current NPA imbroglio.
I guess the writing on the wall is clear!
 
 

 

August 3, 2018

Opinion: Ethics of Artificial Intelligence

July 18, 2018

We have moved from the times when technology was used for convenience to a stage where we are developing machines that can replace humans. Artificial Intelligence (AI), machine learning and deep learning are popular buzzwords in the technology realm. Each day, Geeks are finding new ways to implement AI and further develop their products. Giving machines the power to learn and think like humans has its risks. At such a time, it is appropriate for non-technical considerations to influence technical decisions. Machines make decisions based on optimal solutions; there is no humane thought or empathy behind it. Hence in performing such tasks there is a seldom addressed grey area – Ethics.

We must be cautious while threading into the unprecedented implementation of this powerful technology. The greatest fear regarding the negative implication of AI is one that we might not experience anytime but is believed to be a possibility– the fear that machines become ‘super intelligent’—wherein they grow a conscience and develop runaway tech to overpower humans. Hence, there is a need for a strong set of ground rules or ethics that are upheld while implementing AI for different purposes.

Two major applications of AI that have the potential to revolutionize their respective industries are the application of AI in finance and the use of AI in automated machines.

AI in Finance

A recent report by the Finance Innovation Lab does an effective job in summarizing the impact of the use of AI in the financial services sector. As per the report, it is evident that AI has shown immense potential to help financial services institutions work for customers in a number of ways: it has been recognized as an effective way to help people make sense of their financial habits based on their financial transaction data and market information and suggest the best options available for them. This could help fill the advice gap by offering people insights, recommendations and advice regarding their finances, at scale and in an affordable way. By tracking patterns of behaviour, AI could make it easier to identify people who need help with their finances before a crisis, so that they or other organizations can take pre-emptive action to support them. AI also automates actions that serve our best interests such as transferring money across accounts to avoid overdraft fees and switching to better providers and products. Automation may also be helpful for people with mental health conditions who experience a lack of control over their spending habits and want to pre-commit to certain behaviours. In a broader sense, AI can drive competition in a way that rebalances power between customers and the finance industry.

However, it is undoubted that these opportunities come along with a number of risks. For example, customers may not have access to the AI-driven insights from data, which leads to information asymmetry to the advantage of the industry over customers. Moreover, Fintech startups that develop AI-powered financial services are profit driven and would identify and exploit customers’ behavioral biases. Another major risk is that current modeling techniques require industry experts to modify algorithm parameters and edit datasets. If AI is used for complete automation and algo trading then people no longer have control over the decision making, which could lead to severe meltdowns during times of financial distress. In general, it is likely that businesses will not fully understand the complete capabilities of technology they develop and implement. Additionally, both, businesses and regulators might lack the skills necessary to investigate the technology, especially since regulators that play a key role are generally experts in economics rather than technology. These risks boil down to the fundamental problem that technology, when introduced, might seem enticing but over time could lead to significant issues, which would be irreversible.

AI in self-driving cars:

Companies like Tesla and Uber have been in the spotlight due to crashes of their self-driving cars. While self-driving cars might face minimal difficulty maneuvering roads on a daily basis, it is such incidents that make us doubt an AI’s decision-making ability, thus attracting attention towards the ethics behind the use of AI for self-driving cars. Self-driving cars face three key ethical issues regarding humanity, accountability and privacy:

Our economic system is based on compensation for our contribution to the economy in the form of wages. However, companies can use AI systems to reduce dependence on the human workforce to cut costs thus leading to mass unemployment. This applies to self-driving cars that pose a threat to the jobs of taxi drivers. While the purpose of technology is to serve people to make their tasks easier, AI systems put peoples’ livelihood at risk. Some might argue that the implementation of AI technologies can also create new, better jobs. However, the scale of job role transfers in vague and hence during such times, the march of progress must be slowed to accommodate such humane concerns.

While unemployment posing a threat to humanity is a large-scale issue, accountability is an ethical issue specific to incidents. When there is a car crash, the driver that caused the accident is held accountable. If there is a crash involving two cars and the victim dies, the victim’s family seeks retribution from the law that punishes the driver at fault. But who would be held accountable when there is a crash caused by a self-driving car? It is most likely that the car manufacturer will take liability and pay for damages, as the cost of a few crashes would not outweigh the profitability of self-driving cars. But if there is a fatal crash, then it does not seem ethical to pay money to compensate for the life lost due to a technological error. From a technological standpoint, it is important to keep in mind that during the process of machine learning, the machine is taught how to learn from large datasets. But the logic behind the decision-making through deep learning cannot be comprehended by anyone. It is unclear as to whether it is safe to trust AI systems to perform tasks where there are human lives at stake, especially when we do not know the logic behind the machine’s decision-making ability.

Self-driving cars travel solely using data. This includes data from GPS and data from sensors surrounding the car. The system has sufficient information on the car’s whereabouts and this data will become the most valuable commodity in the driverless car revolution. Ethics would dictate that individuals must have absolute control to not have data sharing beyond the operation of the vehicle. But with the potential profitability behind such data, it is likely that companies might take advantage of this data, thus posing a threat to privacy.

AI technologies are undoubtedly revolutionary with the services it provides but we must fear the negative implications that could be caused by their introduction into markets. AI is being increasingly implemented in multiple fields and it would be best if governments soon introduce policies that address the issues highlighted. Business leaders, engineers and policymakers that make significant decisions regarding the introduction of such technologies are responsible for deciding the fate of this situation and hence while making decisions, they must contemplate fairly between the benefits to individuals versus protecting the welfare of a community.

July 18, 2018

Diversification – An over-rated tool?

June 15, 2018

In the investment parlance, Diversification is the process of spreading out risk by investing in a portfolio of several stocks; such that even if one fails, the others will be able to support the portfolio. While there is merit in the theory of diversification, mindless addition of stocks is likely to diversify return rather than risk.

 

A diversified portfolio’s return will always be lower than the return of the best performing stock, but more importantly, it will also be higher than the worst performing stock leaving the returns somewhere near the Mean. Scholars have tried hard to create methods in order to optimise this Mean Return. The most popular among them is the Capital Asset Pricing Model (or popularly CAPM), which is a derivate of Harry Markowitz’s Modern Portfolio Theory. This method is predominantly used today by most investors and fund managers to evaluate the effect of diversification/risk in a portfolio. Without getting too much into the technicality (…and short comings of the theory), CAPM talks about two risks, Systematic and Unsystematic risk. Systematic or non-diversifiable risk is that which is present in the system (market risk-b). These are risks which cannot be eliminated. Unsystematic or diversifiable risk are those specific to a particular stock. It is to reduce this unsystematic risk that investors/fund managers add more stocks and diversify their portfolios.

A quick review of the portfolio of most Mutual Funds reveal a long list of stocks, some even longer than the index itself. Which brings us to the basic question, why pay a fund manager to invest in such a broad portfolio which entails so much cost and brings down your returns. One might rather recreate the same returns by just buying into the Index ETF. If a fund manager holds a large number of stocks in the portfolio, he/she is either confused, extremely cautious or there is lack of liquidity in the stocks selected. Either way the portfolio is at RISK of under performance!

Enter the

‘Sage of Omaha’ –

“Wide diversification is only required when investors do not understand what they are doing.”

The diversifiable /stock specific risk can be overcome even with a concentrated portfolio of companies. The stocks selected should have unrelated business models, different demand drivers and sufficient liquidity. These stocks would move in an uncorrelated fashion and offer a perfect hedge against each other. It will also help achieve above average return at a much lower cost. Further the schematic allocation of cash will effectively preserve capital when times are wary.

Investors also assign arbitrary caps to single stock exposures in their portfolio (5%,10% etc.). This is done in an attempt to control the risk induced by a single company. Since there is only limited allocation of capital in this case, the rest will have to be allocated to other companies. In most cases the investor tends to select mediocre stocks just to fill the bucket. This is a meaningless exercise and counter-productive. Instead, the investor should pursue further research and arrive at the decision on whether to increase/decrease the exposure based only on the company’s potential. It is always better to invest 50% in a good company rather than 5% in 10 bad ones.

Judicious use of capital and clear understanding of risk are essential while constructing a portfolio. Risk cannot be reduced by confining it within arbitrary numbers. It is more of a philosophy. While Diversification is a useful tool in Risk management, it will have to be used properly for effective results. Meaningful diversification shouldn’t be about adding several companies to the portfolio, rather it should identify the essential and eliminate the rest.

June 15, 2018

Our Testimonials

Aparna Ramesh, Client

Aparna Ramesh, Client

Pelican PMS investment strategy is based on strong fundamentals with emphasis on capital protection. Their investment policy is simple and sustainable and showing patience educating the clients on the investment model. The Portfolio reporting systems are organised with utmost transperancy. Thank u Pelican!!!

Ramki, Client

Ramki, Client

“pelican is one of fund managers managing my portfolio. ..there are many ways to invest and make wealth but wealth creation if it has to sustainable there has to be a methodicity which kanu their MD follows. .other pms invest the moment you invest..but in pelican they time the market and the nifty…I thought it was a contrarian approach but later I understood it was not so….in pelican you shall be assured of safety of capital and a definitive appreciation to your capital…patience to their approach may irk us but it worth the irk”

Ravindran V, Client

Ravindran V, Client

“The most important aspect of Pelican PMS is that their strategies are simple, safe and attainable. For a retired businessman like me who wants to relax, travel, and enjoy without a concern about the investments and security of his wealth, Pelican PMS is my top pick. When you add their periodic and exemplary reporting, I would recommend them as the first choice to anyone.”

Revathi Sanjeev, Client

Revathi Sanjeev, Client

With a hectic work schedule and changing scenarios that we need to keep abreast of, it is difficult to keep a close watch on the financial market too. But why should I worry when I have someone trustworthy to take care of it for me? I am a happy customer, who has turned a profit even in this volatile market, thanks to Pelican PMS, who are diligent in their study and manage portfolios of all their customers. Their approachability and drive towards customers’ satisfaction is remarkable. No investment portfolio is too small and due diligence is never compromised. The firm’s collective experience spans many decades and they apply this expertise thoroughly to advice their investors.

Srikala Venkatesh, Client

Srikala Venkatesh, Client

Pelican Holdings has been advising me and managing my investments for over nine years now. The amount of time money is kept in liquid funds before being deployed into stocks, made me initially wonder whether they would invest at all. The duration of holding while the markets moved up kept me guessing when they would sell. The outcome was good and satisfying. Having gone through the cycle once I am comfortable with the process, patience & method is the theme, not excitement. I like their service and reporting quality too. I wish them all the very best.

Suresh Kalpathi, Client

Suresh Kalpathi, Client

Pelican Holdings have been financial advisors to our Family for over two decades now. They work with integrity, are diligent and advise is based on fundamentals with emphasis on capital protection.Their execution and reporting are transparent. They have been ready to put in time & effort at anytime, through the years, to assist with data & information for reasoned decision making.

Vimal Kumar, Client

Vimal Kumar, Client

keeping in view the fundamentals of the investee company. They are in no hurry to deploy the funds, but rather wait till the valuation is right. This strategy has proven right especially in the current turmoil in the market for the past 2 years. – Vimal Kumar, Client. I am impressed with Pelican team’s patience to invest at the right time and at the right valuation, not swayed by market sentiments,